Commentary

Vanity of vanities

Commentary: Fund managers in December often do stupid things

CHAPEL HILL, N.C.(MarketWatch) — When enumerating some of the really dumb things Wall Street managers do, portfolio window dressing has to be near the top of the list.

And that’s saying something, given the long list of other stupid things they also do.

Window dressing, of course, occurs when a fund manager sells a losing stock right before the end of the year in order to avoid having his disastrous bet on that stock memorialized in year-end reports. Managers engage in this activity for appearance’s sake only, since selling a stock after it has already lost does nothing to improve their funds’ returns.

Why do managers nevertheless continue to engage in the practice?

The best explanation that I’ve seen was advanced nearly a century ago by the famous British economist, John Maynard Keynes: “For it is in the essence of [the long-term investor] that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.”

Regardless of why fund managers might do crazy things, however, their very irrationality creates opportunities for the rest of us. The key is to be willing to step up to the plate and buy some of the stocks that they are irrationally dumping.

George Putnam is one adviser who has that courage. He is editor of The Turnaround Letter, a service that concentrates on buying stocks that are out of favor. He definitely qualifies as a successful long-term investor, at least according to tracking by The Hulbert Financial Digest: Over the last 23 years, which is how long the HFD has tracked his model portfolios, they have beaten the stock market by an average of 2.2 percentage points per year on an annualized basis.

In the latest issue of his newsletter, Putnam offers a list of ten “year-end bounce candidates” that should benefit once we no longer have the artificial year-end selling pressure created in part by window dressing. He compiled this list by starting with the worst-performing stocks this year within the S&P 500
SPX, -1.50%
and then editing it so that he didn’t have more than one stock from any one industry group.

Putnam writes that these stocks have the potential to “become at least short-term winners.” In addition, he adds, “sometimes this year-end bounce will get certain stocks back into the limelight, and they will continue to go up for a prolonged period.”

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